An Auction Rate Securities (ARS) David vs. Goliath story


Imagine you take your hard earned money and at the urging of your broker put it into an account that pays just a bit more than a typical money market fund. Your broker assures you that the account would offer a higher return and would offer liquidity at weekly auctions. Sounds good, no?

Now imagine that you wake up one morning and find that money frozen -- as in you thought you had easy access to your money and now you can't get a penny of it. As I posted last month, that's what happened to investors in Auction Rate Securities (ARS) -- a $330 billion market. Since that post, there have been 583 comments from people who have been affected by this mess.

One commenter, Dave Lehrian, needs to pay taxes on a business he sold. He moved the entire proceeds from selling his business from a bank account at Wells Fargo & Co. (NYSE: WFC) into an ARS. Now he still owes $350,000 in taxes on the sale but can't get his money out of the ARS account to pay them. I can only imagine the frustration he must feel. Here, in his own words, is his story:

"I am not a rich man, but I was fortunate enough to have founded a company in 1999 which in December 2007 was purchased and I ended up with $1.4 million.The money was sitting in my checking account at Wells Fargo so I asked the banker in January 2008 what I should do with it. She put me in touch with a Wells Fargo Investments financial advisor (Catherine Walker based out of the Carmel, CA branch of Wells Fargo Investments) with whom I discussed my situation.

"I wanted a safe, relatively liquid investment that would return better than letting it sit in my checking account. I expressed my need to have it liquid so I could pay taxes in April (which amount to nearly $350k in capital gains taxes) and that I was going to figure out what to do with it more long term in the coming months. She recommended 7 day ARS.

"I didn't know much about them, but she explained they were very safe as they were backed 2:1 with assets and they were liquid within 7 days. They are purchased in $25k chunks and their interest rate is reset weekly in a process known as a "Dutch auction.

"I asked her about the market for these products and she assured me the market was huge and I wouldn't have a problem selling them. She knew of no auction that ever failed. I never received any written information on the product and have yet to receive a prospectus from her even though I have repeatedly asked for one, albeit too late as I was already stuck.

"The end result is this leaves people like me stuck having to borrow money to pay taxes on money I don't have access to! I will have more debt after receiving this money that I had before."

This kind of treatment should scare every investor. I sympathize with David, and I am impressed with the success he achieved in building and selling his business. When he received the proceeds, it would have been a good idea to split it up into 15 accounts -- each below $100,000 -- so they would be FDIC insured.

Now he has his $1.4 million frozen in three preferred issues of ARSs. While the Fed is happy to put $29 billion of taxpayer money at risk to bail out the Goliaths at The Bear Stearns Companies (NYSE: BSC), it can't be bothered to lift a finger for small investors like David -- who is still on the hook to pay his taxes that the Fed uses for such bailouts.

Does this policy inspire your confidence in our financial markets?

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He owns Wells Fargo shares and has no financial interest in Bear Stearns.

Reader Comments (Page 1 of 2)

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Last updated: February 13, 2012: 02:43 AM

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